On Incentives

"Never penalize those who work for us for mistakes or reward them for being right about markets. It will go to their heads, is counterproductive and, in any event, material compensation will not correlate with their ability to predict the future next time."

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What Wall Street Wants to Know

The reason why the stock markets did not respond well to Tim Geithner’s plan is because it was too much politics, too much policy, not enough specifics.  I would suggest that as soon as possible the U.S. Treasury gets specific:

  1. How will the Fed or Treasury price the securities or loans they take from banks or other financial institutions?  Auction?  Most recent mark of “fair value?”
  2. Will the government purchase assets, guarantee a specific floor price or permit the assets to be “put” to a government entity.  Over what time period?
  3. How much money will be available toward the program?  How will guarantees be counted against the government commitment?
  4. How will the support be allocated: to banks? Insurance companies? Credit Card companies; car loans; all loans?  For securities? For securitized packages?
  5. Does the plan envision that there will be shared losses or shared profits with the private sector?  Or shared cash flow?
  6. What will the government get in return for its support?  In short, what’s the deal?

Why are details important?  Because, otherwise, there is no way for the market to know what the financial institutions are worth and external auditors, given the lack of liquidity, are likely to continue to mark “toxic assets” way down.  The markets are very fragile and are looking for answers.  Who cares?  Main Street cares or should care.  The loss of wealth in the stock markets is in the trillions of dollars.  It is far larger than the stimulus plan.  Consumers have seen their accumulated wealth significantly diminished in their pension plans, 401 (k) plans, mutual funds, 529 plans for their children’s education and, of course, in the value of their homes.  Fifty million workers alone have 401 (k) plans; fifty-three million American households own mutual funds.  Tens of millions of others own individual stocks. 

Consumers simply will not spend and, indeed, cannot spend until they have made up a good portion of the losses of their savings.  And if they don’t spend, corporations will be hurt and unemployment will rapidly increase.  Economists call it the “wealth effect.”  Pollsters measure it by the “Consumer Confidence Index”—currently at its lowest level ever.  It is the reality that consumer spending – our economy – is primarily driven by a population, largely middle class, which directly or indirectly has significant investments in the equity markets.

So what does this have to do with getting the specifics on a “bailout” plan?  The uncomfortable truth is that it is not likely there can be a recovery in the equity markets until weak performing assets currently held by both financial institutions and other institutions are either taken off their books or made more liquid – in short – until financial institutions are looked upon with favor.  That is why the market and the financial institutions need specifics.  Otherwise, not only will consumers not spend, financial institutions will not lend.  Financial institutions have led the decline in overall market values and the weakened economy.  They will have to lead us out and the market wants to know the cost and how it will be done.  Otherwise, we can expect a further lack of consumer confidence, less spending, less corporate profit and more lay-offs.

Gene Rotberg was formerly Vice President and Treasurer of the World Bank.